Archive for October, 2017

Yesterday General John Kelly, U. S. Marine Corps (retired) appeared on the Laura Ingraham Show on Fox News and made the following assertion.

I would tell you that Robert E. Lee was an honorable man. He was a man that gave up his country to fight for his state, which 150 years ago was more important than country. It was always loyalty to state first back in those days. Now it’s different today. But the lack of an ability to compromise led to the Civil War, and men and women of good faith on both sides made their stand where their conscience had them make their stand.

General Kelly’s assertion that the cause of the Civil War was “a lack of an ability to compromise” was quickly subjected to severe criticism. But I actually think he made an excellent point. The problem is that he did not say who lacked the ability to compromise. But his subsequent reference to “men and women of good faith on both sides” and his praise for Robert E. Lee suggest that he holds that both sides were lacking “an ability to compromise.” The ability – and willingness — to compromise, the ability – and willingness — to engage in a dialogue with one’s adversaries rather than resort to a civil war to achieve the political objectives animating one section of the country was actually addressed at length by Abraham Lincoln in his magnificent Cooper Union Speech (watch Sam Waterston’s marvelous rendering of that speech at the Cooper Union on the 150th anniversary of the speech in 2010 here), which I have previously quoted from on this blog. Herewith is Lincoln’s take on the subject starting at about the half-way point in the speech.

And now, if they would listen – as I suppose they will not – I would address a few words to the Southern people.

I would say to them: – You consider yourselves a reasonable and a just people; and I consider that in the general qualities of reason and justice you are not inferior to any other people. Still, when you speak of us Republicans, you do so only to denounce us a reptiles, or, at the best, as no better than outlaws. You will grant a hearing to pirates or murderers, but nothing like it to “Black Republicans.” In all your contentions with one another, each of you deems an unconditional condemnation of “Black Republicanism” as the first thing to be attended to. Indeed, such condemnation of us seems to be an indispensable prerequisite – license, so to speak – among you to be admitted or permitted to speak at all. Now, can you, or not, be prevailed upon to pause and to consider whether this is quite just to us, or even to yourselves? Bring forward your charges and specifications, and then be patient long enough to hear us deny or justify.

You say we are sectional. We deny it. That makes an issue; and the burden of proof is upon you. You produce your proof; and what is it? Why, that our party has no existence in your section – gets no votes in your section. The fact is substantially true; but does it prove the issue? If it does, then in case we should, without change of principle, begin to get votes in your section, we should thereby cease to be sectional. You cannot escape this conclusion; and yet, are you willing to abide by it? If you are, you will probably soon find that we have ceased to be sectional, for we shall get votes in your section this very year. You will then begin to discover, as the truth plainly is, that your proof does not touch the issue. The fact that we get no votes in your section, is a fact of your making, and not of ours. And if there be fault in that fact, that fault is primarily yours, and remains until you show that we repel you by some wrong principle or practice. If we do repel you by any wrong principle or practice, the fault is ours; but this brings you to where you ought to have started – to a discussion of the right or wrong of our principle. If our principle, put in practice, would wrong your section for the benefit of ours, or for any other object, then our principle, and we with it, are sectional, and are justly opposed and denounced as such. Meet us, then, on the question of whether our principle, put in practice, would wrong your section; and so meet it as if it were possible that something may be said on our side. Do you accept the challenge? No! Then you really believe that the principle which “our fathers who framed the Government under which we live” thought so clearly right as to adopt it, and indorse it again and again, upon their official oaths, is in fact so clearly wrong as to demand your condemnation without a moment’s consideration.

Some of you delight to flaunt in our faces the warning against sectional parties given by Washington in his Farewell Address. Less than eight years before Washington gave that warning, he had, as President of the United States, approved and signed an act of Congress, enforcing the prohibition of slavery in the Northwestern Territory, which act embodied the policy of the Government upon that subject up to and at the very moment he penned that warning; and about one year after he penned it, he wrote LaFayette that he considered that prohibition a wise measure, expressing in the same connection his hope that we should at some time have a confederacy of free States.

Bearing this in mind, and seeing that sectionalism has since arisen upon this same subject, is that warning a weapon in your hands against us, or in our hands against you? Could Washington himself speak, would he cast the blame of that sectionalism upon us, who sustain his policy, or upon you who repudiate it? We respect that warning of Washington, and we commend it to you, together with his example pointing to the right application of it.

But you say you are conservative – eminently conservative – while we are revolutionary, destructive, or something of the sort. What is conservatism? Is it not adherence to the old and tried, against the new and untried? We stick to, contend for, the identical old policy on the point in controversy which was adopted by “our fathers who framed the Government under which we live;” while you with one accord reject, and scout, and spit upon that old policy, and insist upon substituting something new. True, you disagree among yourselves as to what that substitute shall be. You are divided on new propositions and plans, but you are unanimous in rejecting and denouncing the old policy of the fathers. Some of you are for reviving the foreign slave trade; some for a Congressional Slave-Code for the Territories; some for Congress forbidding the Territories to prohibit Slavery within their limits; some for maintaining Slavery in the Territories through the judiciary; some for the “gur-reat pur-rinciple” that “if one man would enslave another, no third man should object,” fantastically called “Popular Sovereignty;” but never a man among you is in favor of federal prohibition of slavery in federal territories, according to the practice of “our fathers who framed the Government under which we live.” Not one of all your various plans can show a precedent or an advocate in the century within which our Government originated. Consider, then, whether your claim of conservatism for yourselves, and your charge or destructiveness against us, are based on the most clear and stable foundations.

Again, you say we have made the slavery question more prominent than it formerly was. We deny it. We admit that it is more prominent, but we deny that we made it so. It was not we, but you, who discarded the old policy of the fathers. We resisted, and still resist, your innovation; and thence comes the greater prominence of the question. Would you have that question reduced to its former proportions? Go back to that old policy. What has been will be again, under the same conditions. If you would have the peace of the old times, readopt the precepts and policy of the old times.

You charge that we stir up insurrections among your slaves. We deny it; and what is your proof? Harper’s Ferry! John Brown!! John Brown was no Republican; and you have failed to implicate a single Republican in his Harper’s Ferry enterprise. If any member of our party is guilty in that matter, you know it or you do not know it. If you do know it, you are inexcusable for not designating the man and proving the fact. If you do not know it, you are inexcusable for asserting it, and especially for persisting in the assertion after you have tried and failed to make the proof. You need to be told that persisting in a charge which one does not know to be true, is simply malicious slander.

Some of you admit that no Republican designedly aided or encouraged the Harper’s Ferry affair, but still insist that our doctrines and declarations necessarily lead to such results. We do not believe it. We know we hold to no doctrine, and make no declaration, which were not held to and made by “our fathers who framed the Government under which we live.” You never dealt fairly by us in relation to this affair. When it occurred, some important State elections were near at hand, and you were in evident glee with the belief that, by charging the blame upon us, you could get an advantage of us in those elections. The elections came, and your expectations were not quite fulfilled. Every Republican man knew that, as to himself at least, your charge was a slander, and he was not much inclined by it to cast his vote in your favor. Republican doctrines and declarations are accompanied with a continual protest against any interference whatever with your slaves, or with you about your slaves. Surely, this does not encourage them to revolt. True, we do, in common with “our fathers, who framed the Government under which we live,” declare our belief that slavery is wrong; but the slaves do not hear us declare even this. For anything we say or do, the slaves would scarcely know there is a Republican party. I believe they would not, in fact, generally know it but for your misrepresentations of us, in their hearing. In your political contests among yourselves, each faction charges the other with sympathy with Black Republicanism; and then, to give point to the charge, defines Black Republicanism to simply be insurrection, blood and thunder among the slaves.

Slave insurrections are no more common now than they were before the Republican party was organized. What induced the Southampton insurrection, twenty-eight years ago, in which, at least three times as many lives were lost as at Harper’s Ferry? You can scarcely stretch your very elastic fancy to the conclusion that Southampton was “got up by Black Republicanism.” In the present state of things in the United States, I do not think a general, or even a very extensive slave insurrection is possible. The indispensable concert of action cannot be attained. The slaves have no means of rapid communication; nor can incendiary freemen, black or white, supply it. The explosive materials are everywhere in parcels; but there neither are, nor can be supplied, the indispensable connecting trains.

Much is said by Southern people about the affection of slaves for their masters and mistresses; and a part of it, at least, is true. A plot for an uprising could scarcely be devised and communicated to twenty individuals before some one of them, to save the life of a favorite master or mistress, would divulge it. This is the rule; and the slave revolution in Hayti was not an exception to it, but a case occurring under peculiar circumstances. The gunpowder plot of British history, though not connected with slaves, was more in point. In that case, only about twenty were admitted to the secret; and yet one of them, in his anxiety to save a friend, betrayed the plot to that friend, and, by consequence, averted the calamity. Occasional poisonings from the kitchen, and open or stealthy assassinations in the field, and local revolts extending to a score or so, will continue to occur as the natural results of slavery; but no general insurrection of slaves, as I think, can happen in this country for a long time. Whoever much fears, or much hopes for such an event, will be alike disappointed.

In the language of Mr. Jefferson, uttered many years ago, “It is still in our power to direct the process of emancipation, and deportation, peaceably, and in such slow degrees, as that the evil will wear off insensibly; and their places be, pari passu, filled up by free white laborers. If, on the contrary, it is left to force itself on, human nature must shudder at the prospect held up.”

Mr. Jefferson did not mean to say, nor do I, that the power of emancipation is in the Federal Government. He spoke of Virginia; and, as to the power of emancipation, I speak of the slaveholding States only. The Federal Government, however, as we insist, has the power of restraining the extension of the institution – the power to insure that a slave insurrection shall never occur on any American soil which is now free from slavery.

John Brown’s effort was peculiar. It was not a slave insurrection. It was an attempt by white men to get up a revolt among slaves, in which the slaves refused to participate. In fact, it was so absurd that the slaves, with all their ignorance, saw plainly enough it could not succeed. That affair, in its philosophy, corresponds with the many attempts, related in history, at the assassination of kings and emperors. An enthusiast broods over the oppression of a people till he fancies himself commissioned by Heaven to liberate them. He ventures the attempt, which ends in little else than his own execution. Orsini’s attempt on Louis Napoleon, and John Brown’s attempt at Harper’s Ferry were, in their philosophy, precisely the same. The eagerness to cast blame on old England in the one case, and on New England in the other, does not disprove the sameness of the two things.

And how much would it avail you, if you could, by the use of John Brown, Helper’s Book, and the like, break up the Republican organization? Human action can be modified to some extent, but human nature cannot be changed. There is a judgment and a feeling against slavery in this nation, which cast at least a million and a half of votes. You cannot destroy that judgment and feeling – that sentiment – by breaking up the political organization which rallies around it. You can scarcely scatter and disperse an army which has been formed into order in the face of your heaviest fire; but if you could, how much would you gain by forcing the sentiment which created it out of the peaceful channel of the ballot-box, into some other channel? What would that other channel probably be? Would the number of John Browns be lessened or enlarged by the operation?

But you will break up the Union rather than submit to a denial of your Constitutional rights.

That has a somewhat reckless sound; but it would be palliated, if not fully justified, were we proposing, by the mere force of numbers, to deprive you of some right, plainly written down in the Constitution. But we are proposing no such thing.

When you make these declarations, you have a specific and well-understood allusion to an assumed Constitutional right of yours, to take slaves into the federal territories, and to hold them there as property. But no such right is specifically written in the Constitution. That instrument is literally silent about any such right. We, on the contrary, deny that such a right has any existence in the Constitution, even by implication.

Your purpose, then, plainly stated, is that you will destroy the Government, unless you be allowed to construe and enforce the Constitution as you please, on all points in dispute between you and us. You will rule or ruin in all events.

This, plainly stated, is your language. Perhaps you will say the Supreme Court has decided the disputed Constitutional question in your favor. Not quite so. But waiving the lawyer’s distinction between dictum and decision, the Court have decided the question for you in a sort of way. The Court have substantially said, it is your Constitutional right to take slaves into the federal territories, and to hold them there as property. When I say the decision was made in a sort of way, I mean it was made in a divided Court, by a bare majority of the Judges, and they not quite agreeing with one another in the reasons for making it; that it is so made as that its avowed supporters disagree with one another about its meaning, and that it was mainly based upon a mistaken statement of fact – the statement in the opinion that “the right of property in a slave is distinctly and expressly affirmed in the Constitution.”

An inspection of the Constitution will show that the right of property in a slave is not “distinctly and expressly affirmed” in it. Bear in mind, the Judges do not pledge their judicial opinion that such right is impliedly affirmed in the Constitution; but they pledge their veracity that it is “distinctly and expressly” affirmed there – “distinctly,” that is, not mingled with anything else – “expressly,” that is, in words meaning just that, without the aid of any inference, and susceptible of no other meaning.

If they had only pledged their judicial opinion that such right is affirmed in the instrument by implication, it would be open to others to show that neither the word “slave” nor “slavery” is to be found in the Constitution, nor the word “property” even, in any connection with language alluding to the things slave, or slavery; and that wherever in that instrument the slave is alluded to, he is called a “person;” – and wherever his master’s legal right in relation to him is alluded to, it is spoken of as “service or labor which may be due,” – as a debt payable in service or labor. Also, it would be open to show, by contemporaneous history, that this mode of alluding to slaves and slavery, instead of speaking of them, was employed on purpose to exclude from the Constitution the idea that there could be property in man.

To show all this, is easy and certain.

When this obvious mistake of the Judges shall be brought to their notice, is it not reasonable to expect that they will withdraw the mistaken statement, and reconsider the conclusion based upon it?

And then it is to be remembered that “our fathers, who framed the Government under which we live” – the men who made the Constitution – decided this same Constitutional question in our favor, long ago – decided it without division among themselves, when making the decision; without division among themselves about the meaning of it after it was made, and, so far as any evidence is left, without basing it upon any mistaken statement of facts.

Under all these circumstances, do you really feel yourselves justified to break up this Government unless such a court decision as yours is, shall be at once submitted to as a conclusive and final rule of political action? But you will not abide the election of a Republican president! In that supposed event, you say, you will destroy the Union; and then, you say, the great crime of having destroyed it will be upon us! That is cool. A highwayman holds a pistol to my ear, and mutters through his teeth, “Stand and deliver, or I shall kill you, and then you will be a murderer!”

To be sure, what the robber demanded of me – my money – was my own; and I had a clear right to keep it; but it was no more my own than my vote is my own; and the threat of death to me, to extort my money, and the threat of destruction to the Union, to extort my vote, can scarcely be distinguished in principle.

“The lack of an ability to compromise” was clearly a deficiency of one — and only one — party to the Civil War, the side for which Robert E. Lee chose to do battle. That point was conclusively demonstrated by Lincoln in his Cooper Union Speech. General Kelly, read the speech.

It seems that an announcement about who will be appointed as Fed Chairman after Janet Yellen’s terms expires early next year is imminent. Although there are sources in the Administration, e.g., the President, indicating that Janet Yellen may be reappointed, the betting odds strongly favor Jerome Powell, a Republican currently serving as a member of the Board of Governors, over the better-known contender, John Taylor, who has earned a considerable reputation as an academic economist, largely as author of the so-called Taylor Rule, and has also served as a member of the Council of Economic Advisers and the Treasury in previous Republican administrations.

Taylor’s support seems to be drawn from the more militant ideological factions within the Republican Party owing to his past criticism of Fed’s quantitative-easing policy after the financial crisis and little depression, having famously predicted that quantitative easing would revive dormant inflationary pressures, presaging a return to the stagflation of the 1970s, while Powell, who has supported the Fed’s policies under Bernanke and Yellen, is widely suspect in the eyes of the Republican base as a just another elitist establishmentarian inhabiting the swamp that the new administration was elected to drain. Nevertheless, Taylor’s academic background, his prior government service, and his long-standing ties to the US and international banking and financial institutions make him a less than ideal torch bearer for the true-blue (or true-red) swamp drainers whose ostensible goal is less to take control of the Fed than to abolish it. To accommodate both the base and the establishment, it is possible that, as reported by Breitbart, both Powell and Taylor will be appointed, one replacing Yellen as chairman, the other replacing Stanley Fischer as vice-chairman.

Seeing no evidence that Taylor has a sufficient following for his appointment to provide any political benefit, I have little doubt that it will be Powell who replaces Yellen, possibly along with Taylor as Vice-Chairman, if Taylor, at the age of 71, is willing to accept a big pay cut, just to take the vice-chairmanship with little prospect of eventually gaining the top spot he has long coveted.

Although I think it unlikely that Taylor will be the next Fed Chairman, the recent flurry of speculation about his possible appointment prompted me to look at a recent talk that he gave at the Federal Reserve Bank of Boston Conference on the subject: Are Rules Made to be Broken? Discretion and Monetary Policy. The title of his talk “Rules versus Discretion: Assessing the Debate over Monetary Policy” is typical of Taylor’s very low-key style, a style that, to his credit, is certainly not calculated to curry favor with the Fed-bashers who make up a large share of a Republican base that demands constant attention and large and frequently dispensed servings of red meat.

I found several things in Taylor’s talk notable. First, and again to his credit, Taylor does, on occasion, acknowledge the possibility that other interpretations of events from his own are possible. Thus, in arguing that the good macroeconomic performance (“the Great Moderation”) from about 1985 to 2003, was the result of the widespread adoption of “rules-based” monetary policy, and that the subsequent financial crisis and deep recession were the results of the FOMC’s having shifted, after the 2001 recession, from that rules-based policy to a discretionary policy, by keeping interest rates too low for too long, Taylor did at least recognize the possibility that the reason that the path of interest rates after 2003 departed from the path that, he claims, had been followed during the Great Moderation was that the economy was entering a period of inherently greater instability in the early 2000s than in the previous two decades because of external conditions unrelated to actions taken by the Fed.

The other view is that the onset of poor economic performance was not caused by a deviation from policy rules that were working, but rather to other factors. For example, Carney (2013) argues that the deterioration of performance in recent years occurred because “… the disruptive potential of financial instability—absent effective macroprudential policies—leads to a less favourable Taylor frontier.” Carney (2013) illustrated his argument with a shift in the tradeoff frontier as did King (2012). The view I offer here is that the deterioration was due more to a move off the efficient policy frontier due to a change in policy. That would suggest moving back toward the type of policy rule that described policy decisions during the Great Moderation period. (p. 9)

But despite acknowledging the possibility of another view, Taylor offers not a single argument against it. He merely reiterates his own unsupported opinion that the policy post-2003 became less rule-based than it had been from 1985 to 2003. However, later in his talk in a different context, Taylor does return to the argument that the Fed’s policy after 2003 was not fundamentally different from its policy before 2003. Here Taylor is assuming that Bernanke is acknowledging that there was a shift in from the rules-based monetary policy of 1985 to 2003, but that the post-2003 monetary policy, though not rule-based as in the way that it had been in 1985 to 2003, was rule-based in a different sense. I don’t believe that Bernanke would accept that there was a fundamental change in the nature of monetary policy after 2003, but that is not really my concern here.

At a recent Brookings conference, Ben Bernanke argued that the Fed had been following a policy rule—including in the “too low for too long” period. But the rule that Bernanke had in mind is not a rule in the sense that I have used it in this discussion, or that many others have used it.

Rather it is a concept that all you really need for effective policy making is a goal, such as an inflation target and an employment target. In medicine, it would be the goal of a healthy patient. The rest of policymaking is doing whatever you as an expert, or you as an expert with models, thinks needs to be done with the instruments. You do not need to articulate or describe a strategy, a decision rule, or a contingency plan for the instruments. If you want to hold the interest rate well below the rule-based strategy that worked well during the Great Moderation, as the Fed did in 2003-2005, then it’s ok, if you can justify it in terms of the goal.

Bernanke and others have argued that this approach is a form of “constrained discretion.” It is an appealing term, and it may be constraining discretion in some sense, but it is not inducing or encouraging a rule as the language would have you believe. Simply having a specific numerical goal or objective function is not a rule for the instruments of policy; it is not a strategy; in my view, it ends up being all tactics. I think there is evidence that relying solely on constrained discretion has not worked for monetary policy. (pp. 16-17)

Taylor has made this argument against constrained discretion before in an op-ed in the Wall Street Journal (May 2, 2015). Responding to that argument I wrote a post (“Cluelessness about Strategy, Tactics and Discretion”) which I think exposed how thoroughly confused Taylor is about what a monetary rule can accomplish and what the difference is between a monetary rule that specifies targets for an instrument and a monetary rule that specifies targets for policy goals. At an even deeper level, I believe I also showed that Taylor doesn’t understand the difference between strategy and tactics or the meaning of discretion. Here is an excerpt from my post of almost two and a half years ago.

Taylor denies that his steady refrain calling for a “rules-based policy” (i.e., the implementation of some version of his beloved Taylor Rule) is intended “to chain the Fed to an algebraic formula;” he just thinks that the Fed needs “an explicit strategy for setting the instruments” of monetary policy. Now I agree that one ought not to set a policy goal without a strategy for achieving the goal, but Taylor is saying that he wants to go far beyond a strategy for achieving a policy goal; he wants a strategy for setting instruments of monetary policy, which seems like an obvious confusion between strategy and tactics, ends and means.

Instruments are the means by which a policy is implemented. Setting a policy goal can be considered a strategic decision; setting a policy instrument a tactical decision. But Taylor is saying that the Fed should have a strategy for setting the instruments with which it implements its strategic policy. (OED, “instrument – 1. A thing used in or for performing an action: a means. . . . 5. A tool, an implement, esp. one used for delicate or scientific work.”) This is very confused.

Let’s be very specific. The Fed, for better or for worse – I think for worse — has made a strategic decision to set a 2% inflation target. Taylor does not say whether he supports the 2% target; his criticism is that the Fed is not setting the instrument – the Fed Funds rate – that it uses to hit the 2% target in accordance with the Taylor rule. He regards the failure to set the Fed Funds rate in accordance with the Taylor rule as a departure from a rules-based policy. But the Fed has continually undershot its 2% inflation target for the past three [now almost six] years. So the question naturally arises: if the Fed had raised the Fed Funds rate to the level prescribed by the Taylor rule, would the Fed have succeeded in hitting its inflation target? If Taylor thinks that a higher Fed Funds rate than has prevailed since 2012 would have led to higher inflation than we experienced, then there is something very wrong with the Taylor rule, because, under the Taylor rule, the Fed Funds rate is positively related to the difference between the actual inflation rate and the target rate. If a Fed Funds rate higher than the rate set for the past three years would have led, as the Taylor rule implies, to lower inflation than we experienced, following the Taylor rule would have meant disregarding the Fed’s own inflation target. How is that consistent with a rules-based policy?

This is such an obvious point – and I am hardly the only one to have made it – that Taylor’s continuing failure to respond to it is simply inexcusable. In his apologetics for the Taylor rule and for legislation introduced (no doubt with his blessing and active assistance) by various Republican critics of Fed policy in the House of Representatives, Taylor repeatedly insists that the point of the legislation is just to require the Fed to state a rule that it will follow in setting its instrument with no requirement that Fed actually abide by its stated rule. The purpose of the legislation is not to obligate the Fed to follow the rule, but to merely to require the Fed, when deviating from its own stated rule, to provide Congress with a rationale for such a deviation. I don’t endorse the legislation that Taylor supports, but I do agree that it would be desirable for the Fed to be more forthcoming than it has been in explaining the reasoning about its monetary-policy decisions, which tend to be either platitudinous or obfuscatory rather than informative. But if Taylor wants the Fed to be more candid and transparent in defending its own decisions about monetary policy, it would be only fitting and proper for Taylor, as an aspiring Fed Chairman, to be more forthcoming than he has yet been about the obvious, and rather scary, implications of following the Taylor Rule during the period since 2003.

If Taylor is nominated to be Chairman or Vice-Chairman of the Fed, I hope that, during his confirmation hearings, he will be asked to explain what the implications of following the Taylor Rule would have been in the post-2003 period.

As the attached figure shows PCE inflation (excluding food and energy prices) was 1.9 percent in 2004. If inflation in 2004 was less than the 2% inflation target assumed by the Taylor Rule, why does Taylor think that raising interest rates in 2004 would have been appropriate? And if inflation in 2005 was merely 2.2%, just barely above the 2% target, what rate should the Fed Funds rate have reached in 2005, and how would that rate have affected the fairly weak recovery from the 2001 recession? And what is the basis for Taylor’s assessment that raising the Fed Funds rate in 2005 to a higher level than it was raised to would have prevented the subsequent financial crisis?

Taylor’s implicit argument is that by not raising interest rates as rapidly as the Taylor rule required, the Fed created additional uncertainty that was damaging to the economy. But what was the nature of the uncertainty created? The Federal Funds rate is merely the instrument of policy, not the goal of policy. To argue that the Fed was creating additional uncertainty by not changing its interest rate in line with the Taylor rule would only make sense if the economic agents care about how the instrument is set, but if it is an instrument the importance of the Fed Funds rate is derived entirely from its usefulness in achieving the policy goal of the Fed and the policy goal was the 2% inflation rate, which the Fed came extremely close to hitting in the 2004-06 period, during which Taylor alleges that the Fed’s monetary policy went off the rails and became random, unpredictable and chaotic.

If you calculate the absolute difference between the observed yearly PCE inflation rate (excluding food and energy prices) and the 2% target from 1985 to 2003 (Taylor’s golden age of monetary policy) the average yearly deviation was 0.932%. From 2004 to 2015, the period of chaotic monetary policy in Taylor’s view, the average yearly deviation between PCE inflation and the 2% target was just 0.375%. So when was monetary policy more predictable? Even if you just look at the last 12 years of the golden age (1992 to 2003), the average annual deviation was 0.425%.

The name Larry Summers is in the title of this post, but I haven’t mentioned him yet, so let me explain where Larry Summers comes into the picture. In his talk, Taylor mentions a debate about rules versus discretion that he and Summers had at the 2013 American Economic Association meetings and proceeds to give the following account of the key interchange in that debate.

Summers started off by saying: “John Taylor and I have, it will not surprise you . . . a fundamental philosophical difference, and I would put it in this way. I think about my doctor. Which would I prefer: for my doctor’s advice, to be consistently predictable, or for my doctor’s advice to be responsive to the medical condition with which I present? Me, I’d rather have a doctor who most of the time didn’t tell me to take some stuff, and every once in a while said I needed to ingest some stuff into my body in response to the particular problem that I had. That would be a doctor who’s [sic] [advice], believe me, would be less predictable.” Thus, Summers argues in favor of relying on an all-knowing expert, a doctor who does not perceive the need for, and does not use, a set of guidelines, but who once in a while in an unpredictable way says to ingest some stuff. But as in economics, there has been progress in medicine over the years. And much progress has been due to doctors using checklists, as described by Atul Gawande.

Of course, doctors need to exercise judgement in implementing checklists, but if they start winging it or skipping steps the patients usually suffer. Experience and empirical studies show that checklist-free medicine is wrought with dangers just as rules-free, strategy-free monetary policy is. (pp. 15-16)

Taylor’s citation of Atul Gawande, author of The Checklist Manifesto, is pure obfuscation. To see how off-point it is, have a look at this review published in the Seattle Times.

“The Checklist Manifesto” is about how to prevent highly trained, specialized workers from making dumb mistakes. Gawande — who appears in Seattle several times early next week — is a surgeon, and much of his book is about surgery. But he also talks to a construction manager, a master chef, a venture capitalist and the man at The Boeing Co. who writes checklists for airline pilots.

Commercial pilots have been using checklists for decades. Gawande traces this back to a fly-off at Wright Field, Ohio, in 1935, when the Army Air Force was choosing its new bomber. Boeing’s entry, the B-17, would later be built by the thousands, but on that first flight it took off, stalled, crashed and burned. The new airplane was complicated, and the pilot, who was highly experienced, had forgotten a routine step.

For pilots, checklists are part of the culture. For surgical teams they have not been. That began to change when a colleague of Gawande’s tried using a checklist to reduce infections when using a central venous catheter, a tube to deliver drugs to the bloodstream.

The original checklist: wash hands; clean patient’s skin with antiseptic; use sterile drapes; wear sterile mask, hat, gown and gloves; use a sterile dressing after inserting the line. These are all things every surgical team knows. After putting them in a checklist, the number of central-line infections in that hospital fell dramatically.

Then came the big study, the use of a surgical checklist in eight hospitals around the world. One was in rural Tanzania, in Africa. One was in the Kingdom of Jordan. One was the University of Washington Medical Center in Seattle. They were hugely different hospitals with much different rates of infection.

Use of the checklist lowered infection rates significantly in all of them.

Gawande describes the key things about a checklist, much of it learned from Boeing. It has to be short, limited to critical steps only. Generally the checking is not done by the top person. In the cockpit, the checklist is read by the copilot; in an operating room, Gawande discovered, it is done best by a nurse.

Gawande wondered whether surgeons would accept control by a subordinate. Which was stronger, the culture of hierarchy or the culture of precision? He found reason for optimism in the following dialogue he heard in the hospital in Amman, Jordan, after a nurse saw a surgeon touch a nonsterile surface:

Nurse: “You have to change your glove.”

Surgeon: “It’s fine.”

Nurse: “No, it’s not. Don’t be stupid.”

In other words, the basic rule underlying the checklist is simply: don’t be stupid. It has nothing to do with whether doctors should exercise judgment, or “winging it,” or “skipping steps.” What was Taylor even thinking? For a monetary authority not to follow a Taylor rule is not analogous to a doctor practicing checklist-free medicine.

As it happens, I have a story of my own about whether following numerical rules without exercising independent judgment makes sense in practicing medicine. Fourteen years ago, on the Friday before Labor Day, I was exercising at home and began to feeling chest pains. After ignoring the pain for a few minutes, I stopped and took a shower and then told my wife that I thought I needed to go to the hospital, because I was feeling chest pains – I was still in semi-denial about what I was feeling – my wife asked me if she should call 911, and I said that that might be a good idea. So she called 911, and told the operator that I was feeling chest pains. Within a couple of minutes, two ambulances arrived, and I was given an aspirin to chew and a nitroglycerine tablet to put under my tongue. I was taken to the emergency room at the hospital nearest to my home. After calling 911, my wife also called our family doctor to let him know what was happening and which hospital I was being taken to. He then placed a call to a cardiologist who had privileges at that hospital who happened to be making rounds there that morning.

When I got to the hospital, I was given an electrocardiogram, and my blood was taken. I was also asked to rate my pain level on a scale of zero to ten. The aspirin and nitroglycerine had reduced the pain level slightly, but I probably said it was at eight or nine. However, the ER doc looked at the electrocardiogram results and the enzyme levels in my blood, and told me that there was no indication that I was having a heart attack, but that they would keep me in the ER for observation. Luckily, the cardiologist who had been called by my internist came to the ER, and after talking to the ER doc, looking at the test results, came over to me and started asking me questions about what had happened and how I was feeling. Although the test results did not indicate that I was having heart attack, the cardiologist quickly concluded that what I was experiencing likely was a heart attack. He, therefore, hinted to me that I should request to be transferred to another nearby hospital, which not only had a cath lab, as the one I was then at did, but also had an operating room in which open heart surgery could be performed, if that would be necessary. It took a couple of tries on his part before I caught on to what he was hinting at, but as soon as I requested to be transferred to the other hospital, he got me onto an ambulance ASAP so that he could meet me at the hospital and perform an angiogram in the cath lab, cancelling an already scheduled angiogram.

The angiogram showed that my left anterior descending artery was completely blocked, so open-heart surgery was not necessary; angioplasty would be sufficient to clear the artery, which the cardiologist performed, also implanting two stents to prevent future blockage. I remained in the cardiac ICU for two days, and was back home on Monday, when my rehab started. I was back at work two weeks later.

The willingness of my cardiologist to use his judgment, experience and intuition to ignore the test results indicating that I was not having a heart attack saved my life. If the ER doctor, following the test results, had kept me in the ER for observation, I would have been dead within a few hours. Following the test results and ignoring what the patient was feeling would have been stupid. Luckily, I was saved by a really good cardiologist. He was not stupid; he could tell that the numbers were not telling the real story about what was happening to me.

We now know that, in the summer of 2008, the FOMC, being in the thrall of headline inflation numbers allowed a recession that had already started at the end of 2007 to deteriorate rapidly, pr0viding little or no monetary stimulus, to an economy when nominal income was falling so fast that debts coming due could no longer be serviced. The financial crisis and subsequent Little Depression were caused by the failure of the FOMC to provide stimulus to a failing economy, not by interest rates having been kept too low for too long after 2003. If John Taylor still hasn’t figured that out – and he obviously hasn’t — he should not be allowed anywhere near the Federal Reserve Board.

How do macroeconomists write the history of their own discipline? This article provides a careful reconstruction of the history of macroeconomics told by the practitioners working today in the dynamic stochastic general equilibrium (DSGE) approach.

Such a tale is a “standard narrative”: a widespread and “standardizing” view of macroeconomics as a field evolving toward “scientific progress”. The standard narrative explains scientific progress as resulting from two factors: “consensus” about theory and “technical change” in econometric tools and computational power. This interpretation is a distinctive feature of central banks’ technical reports about their DSGE models.

Furthermore, such a view on “consensus” and “technical change” is a significantly different view with respect to similar tales told by macroeconomists in the past — which rather emphasized the role of “scientific revolutions” and struggles among competing “schools of thought”. Thus, this difference raises some new questions for historians of macroeconomics.

Sergi’s paper is too long and too rich in content to easily summarize in this post, so what I will do is reproduce and comment on some of the many quotations provided by Sergi, taken mostly from central-bank reports, but also from some leading macroeconomic textbooks and historical survey papers, about the “progress” of modern macroeconomics, and especially about the critical role played by “microfoundations” in achieving that progress. The general tenor of the standard narrative is captured well by the following quotations from V. V. Chari

[A]ny interesting model must be a dynamic stochastic general equilibrium model. From this perspective, there is no other game in town. […] A useful aphorism in macroeconomics is: “If you have an interesting and coherent story to tell, you can tell it in a DSGE model. (Chari 2010, 2)

I could elaborate on this quotation at length, but I will just leave it out there for readers to ponder with a link to an earlier post of mine about methodological arrogance. Instead I will focus on two other sections of Sergi’s paper “the five steps of theoretical progress” and “microfoundations as theoretical progress.” Here is how Sergi explains the role of the five steps:

The standard narrative provides a detailed account of the progressive evolution toward the synthesis. Following a teleological perspective, each step of this evolution is an incremental, linear improvement of the theoretical tool box for model building. The standard narrative identifies five steps . . . . Each step corresponds to the emergence of a school of thought. Therefore, in the standard narrative, there are not such things as competing schools of thought and revolutions. Firstly, because schools of thought are represented as a sequence; one school (one step) is always leading to another school (the following step), hence different schools are not coexisting for a long period of time. Secondly, there are no revolutions because, while emerging, new schools of thought [do] not overthrow the previous ones; instead, they suggest improvements and amendments, that are accepted as an improvement by pre-existing schools therefore, accumulation of knowledge takes place thanks to consensus. (pp. 17-18)

The first step in the standard narrative is the family of Keynesian macroeconometric models of the 1950s and 1960s, the primitive ancestors of the modern DSGE models. The second step was the emergence of New Classical macroeconomics which introduced the ideas of rational expectations and dynamic optimization into theoretical macroeconomic discourse in the 1970s. The third step was the development, inspired by New Classical ideas, of Real-Business-Cycle models of the 1980s, and the fourth step was introduction of New Keynesian models in the late 1980s and 1990s that tweaked the Real-Business-Cycle models in ways that rationalized the use of counter-cyclical macroeconomic policy within the theoretical framework of the Real-Business-Cycle approach. The final step, the DSGE model, emerged more or less naturally as a synthesis of the converging Real-Business-Cycle and New Keynesian approaches.

After detailing the five steps of theoretical progress, Sergi focuses attention on “the crucial improvement” that allowed the tool box of macroeconomic modelling to be extended in such a theoretically fruitful way: the insistence on providing explicit microfoundations for macroeconomic models. He writes:

Abiding [by] the Lucasian microfoundational program is put forward by DSGE modellers as the very fundamental essence of theoretical progress allowed by [the] consensus. As Sanajay K. Chugh (University of Pennsylvania) explains in the historical chapter of his textbook, microfoundations is all what modern macroeconomics is about: (p. 20)

Modern macroeconomics begin by explicitly studying the microeconomic principles of utility maximization, profit maximization and market-clearing. [. . . ] This modern macroeconomics quickly captured the attention of the profession through the 1980s [because] it actually begins with microeconomic principles, which was a rather attractive idea. Rather than building a framework of economy-wide events from the top down [. . .] one could build this framework using microeconomic discipline from the bottom up. (Chugh 2015, 170)

Chugh’s rationale for microfoundations is a naïve expression of reductionist bias dressed up as simple homespun common-sense. Everyone knows that you should build from the bottom up, not from the top down, right? But things are not always quite as simple as they seem. Here is an attempt to present microfoundations as being cutting-edge and sophisticated offered in a 2009 technical report written by Cuche-Curti et al. for the Swiss National Bank.

The key property of DSGE models is that they rely on explicit micro-foundations and a rational treatment of expectations in a general equilibrium context. They thus provide a coherent and compelling theoretical framework for macroeconomic analysis. (Cuche-Curti et al. 2009, 6)

A similar statement is made by Gomes et al in a 2010 technical report for the European Central Bank:

The microfoundations of the model together with its rich structure allow [us] to conduct a quantitative analysis in a theoretically coherent and fully consistent model setup, clearly spelling out all the policy implications. (Gomes et al. 2010, 5)

These laudatory descriptions of the DSGE model stress its “coherence” as a primary virtue. What is meant by “coherence” is spelled out more explicitly in a 2006 technical report describing NEMO, a macromodel of the Norwegian economy, by Brubakk et al. for the Norges Bank.

Various agents’ behavior is modelled explicitly in NEMO, based on microeconomic theory. A consistent theoretical framework makes it easier to interpret relationships and mechanisms in the model in the light of economic theory. One advantage is that we can analyse the economic effects of changes of a more structural nature […] [making it] possible to provide a consistent and detailed economic rationale for Norges Bank’s projections for the Norwegian economy. This distinguishes NEMO from purely statistical models, which to a limited extent provide scope for economic interpretations. (Brubakk and Sveen 2009, 39)

By creating microfounded models, in which all agents are optimizers making choices consistent with the postulates of microeconomic theory, DSGE model-builders, in effect, create “laboratories” from which to predict the consequences of alternative monetary policies, enabling policy makers to make informed policy choices. I pause merely to note and draw attention to the tendentious and misleading misappropriation of the language of empirical science by these characteristically self-aggrandizing references to DSGE models as “laboratories” as if what was going on in such models was determined by an actual physical process, as is routinely the case in the laboratories of physical and natural scientists, rather than speculative exercises in high-level calculations derived from the manipulation of DSGE models.

As a result of recent advances in macroeconomic theory and computational techniques, it has become feasible to construct richly structured dynamic stochastic general equilibrium models and use them as laboratories for the study of business cycles and for the formulation and analysis of monetary policy. (Cuche-Curri et al. 2009, 39)

Policy makers can be confident that the conditional predictions corresponding to the policy alternative under consideration, which are derived from their “laboratory” DSGE models, because those models, having been constructed on the basis of the postulates of economic theory, are therefore microfounded, embodying deep structural parameters that are invariant to policy changes. Microfounded models are thus immune to the Lucas Critique of macroeconomic policy evaluation, under which the empirically estimated coefficients of traditional Keynesian macroeconometric models cannot be assumed to remain constant under policy changes, because those coefficient estimates are themselves conditional to policy choices.

Here is how the point is made in three different central bank technical reports: by Argov et al. in a 2012 technical report about MOISE, a DSGE model for the Israeli economy, by Cuche-Curti et al. and by Medina and Soto in a 2006 technical report about a new DSGE model for the Chilean economy for the Central Bank of Chile.

Being micro-founded, the model enables the central bank to assess the effect of its alternative policy choices on the future paths of the economy’s endogenous variables, in a way that is immune to the Lucas critique. (Argov et al. 2012, 5)

[The DSGE] approach has three distinct advantages in comparison to other modelling strategies. First and foremost, its microfoundations should allow it to escape the Lucas critique. (Cuche-Curti et al. 2009, 6)

The main advantage of this type of model, over more traditional reduce-form macro models, is that the structural interpretation of their parameters allows [it] to overcome the Lucas Critique. This is clearly an advantage for policy analysis. (Medina and Soto, 2006, 2)

These quotations show clearly that escaping, immunizing, or overcoming the Lucas Critique is viewed by DSGE modelers as the holy grail of macroeconomic model building and macroeconomic policy analysis. If the Lucas Critique cannot be neutralized, the coefficient estimates derived from reduced-form macroeconometric models cannot be treated as invariant to policy and therefore cannot provide a secure basis for predicting the effects of alternative policies. But DSGE models allow deep structural relationships, reflecting the axioms underlying microeconomic theory, to be estimated. Because they reflect the deep, and presumably stable, microeconomic structure of the economy, estimates of deep parameters derived from DSGE models, DSGE modelers claim that these estimates provide policy makers with a reliable basis for conditional forecasting of the effects of macroeconomic policy.

Because of the consistently poor track record of DSGE models in actual forecasting (for evidence of that poor track record see the paper by Carlaw and Lipsey and my post about their paper) comparing the predictive performance of DSGE models with more traditional macroeconometric models), the emphasis placed on the Lucas Critique by DSGE modelers has an apologetic character, DSGE modelers having to account for the relatively poor comparative predictive power of DSGE models by relentlessly invoking the Lucas Critique in trying to account for, and explain away, the poor predictive performance of the DSGE models. But if DSGE models really are better than traditional macro models why are their unconditional predictions not at least as good as those of traditional macroeconometric models? Obviously estimates of the deep structural relationships provided by microfounded models are not as reliable as DSGE apologetics tries to suggest.

And the reason that the estimates of deep structural relationships derived from DSGE models are not reliable is that those models, no less than traditional macroeconometric models, are subject to the Lucas Critique, the deep microeconomic structural relationships embodied in DSGE models being conditional on the existence of a unique equilibrium solution that persists long enough for the structural relationships characterizing that equilibrium to be inferred from the data-generating mechanism whereby those models are estimated. (I have made this point previously here.) But if the data-generating mechanism does not conform to the unique general equilibrium upon whose existence the presumed deep structural relationships of microeconomic theory embodied in DSGE models are conditioned, the econometric estimates derived from DSGE models cannot capture the desired deep structural relationships, and the resulting structural estimates are therefore incapable of providing a reliable basis for macroeconomic-policy analysis or for conditional forecasts of the effects of alternative policies, much less unconditional forecasts of endogenous macroeconomic variables.

Of course, the problem is even more intractable than the discussion above implies, because there is no reason why the deep structural relationships corresponding to a particular equilibrium should be invariant to changes in the equilibrium. So any change in economic policy that displaces a pre-existing equilibrium, let alone any other unforeseen technological change or change in tastes or resource endowments that displaces a pre-existing equilibrium will necessarily cause all the deep structural relationships to change correspondingly. So the deep structural parameters upon whose invariance the supposedly unique capacity of DSGE models to provide policy analysis upon which policy makers can rely simply don’t exist. Policy making based on DSGE models is as much an uncertain art requiring the exercise of finely developed judgment and intuition as policy making based on any other kind of economic modeling. DSGE models provide no uniquely reliable basis for making macroeconomic policy.

Chari, V. V. (2010). Testimony before the committee on Science and Technology, Subcommittee on Investigations and Oversight, US House of Representatives. In Building a Science of Economics for the Real World.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.